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Abstract

The European Union Emissions Trading Scheme (EU ETS) constrains industrial polluters to buy/sell CO2 allowances depending on a regional depolluting objective of -8% of CO2 emissions by 2012 compared to 1990 levels. Companies may also buy carbon offsets from developing countries, funding emissions cuts there instead, under a Kyoto Protocol Clean Development Mechanism (CDM). This chapter critically analyzes the price relationships in the EU emissions trading system. The United Nations Framework Convention on Climate Change (UNFCCC) delivers credits that may be used by European companies for their compliance needs. Certified Emissions Reductions (CERs) from CDM projects are credits flowing into the global compliance market generated through emission reductions. EUAs (European Union Allowances) are the tradable unit under the EU ETS. Besides, the EU Linking Directive allows the import for compliance into the EU ETS up to 13.4% of CERs on average. This chapter details the idiosyncratic risks affecting each emissions market, be it in terms of regulatory uncertainty, economic activity, industrial structure, or the impact of other energy markets. Besides, based on a careful analysis of the EUA and CER price paths, this chapter assesses common risk factors by focusing more particularly on the role played by the CER import limit within the ETS.

Background

In this section, we comment first on the price developments of EUAs and CERs.

Primary CERs (pCERs, which are generated from the project in the developing country) have a delivery risk, while secondary CERs (sCERs, which have been sold on the secondary credits market) are already generated and issued by the CDM Executive Board, and are hence risk-free. The risks attached to primary CERs are linked to the United Nations’ “International Transaction Log” (ITL) connection, the import limit, and the performance for operating projects, to which we may add a high volume of registered projects, as well as registration and methodological risks for proposed projects. The risks attached to secondary CERs are the ITL connection, the import limit, and eligibility criteria to be met for transfer of a CER from one EU registry to another. In the exchange contract (sCER), the seller agrees to pay EUAs or cash in case of non-delivery.